The chips are down for China

As the year of living dangerously draws to a volatile close, historians will long debate its most consequential event. Russia’s invasion of Ukraine, the lingering effects of Covid and fears that China’s president Xi Jinping may unleash war on Taiwan are prime candidates. But a package of US export restrictions that aims to kneecap China’s burgeoning technology sector threatens to overshadow them all.

Last month, an obscure agency in the US Commerce Department known as the Bureau of Industry and Security imposed semiconductor export restrictions on dozens of Chinese companies and research institutions after the Pentagon expanded its own blacklist. But the real hammer blow was the Biden administration’s decision to bar companies worldwide from selling supercomputer and artificial intelligence chips to China that are made with US software, machinery or technology.

This is a major blow to China’s tech aspirations, although it remains to be seen how effectively the US will be able to enforce these restrictions.

Despite advances in producing semiconductors, China still relies heavily on foreign supplies of advanced chips as well as American technology and equipment used in its chip making fabrication plants, or “fabs”. China’s leading domestic chip producer SMIC produces 14-nanometer chips, a measure of how densely components can be packed into a single chip. The smaller the better. Industry leaders TSMC (Taiwan) and Samsung (South Korea) can produce wafer thin 5 and 3-nanometer chips, which are roughly three times faster.

Jon Bateman, senior fellow in technology and international affairs at the Carnegie Endowment for International Peace believes that these controls will make it much harder and more expensive for China to catch up, revealing a single-minded US focus “on thwarting Chinese capabilities at a broad and fundamental level”.

The primary damage to China will be economic. The number of Chinese companies on the US Entity List – a compilation of black-listed companies – quadrupled from 130 to 532 between 2018 and 2022. Some will be destroyed. Others will be curtailed or become emaciated zombies. SMIC is directly in Washington’s sights. Previously targeted Huawei, once China’s tech champion, lost 30 per cent of sales in 2021 and is struggling.

In an interview with The New York Times, Matthew Pottinger, Trump administration deputy national security adviser, says that “the Biden administration understands now that it isn’t enough for America to run faster – we also need to actively hamper the PRC’s ambitions for tech dominance. This marks a serious evolution in the ­administration’s thinking”.

The US is “forcefully decoupling the entire advanced technology supply chain before China insources it”, says tech analyst Dylan Patel. It’s essentially a form of economic containment which, if enforced, will cripple China’s ability to design and make the high-end computer chips that power modern weapons.

It’s also a serious setback to Xi’s professed desire to dominate the commanding heights of tomorrow’s hi-tech industries. Advanced chips are the brains of number crunching supercomputers and AI that are driving innovation across multiple sectors – from bioscience and engineering to transport, communications, e-commerce, energy systems, robotics, space, climate science modelling and medical imaging.

Bateman says that “restrictionists” within the Biden administration have won a long-running debate about how the US should push back against China’s techno-mercantilism. Harsher measures are on the cards.

Expect to see them applied in other critical sectors like biotech, manufacturing and finance where America still has what Nobel prize-winning economist Paul Krugman calls “escalation dominance”. The US has already used its financial muscle to inflict heavy punishment on Russia for its invasion of Ukraine. It won’t hesitate to do so against China should Xi decide to forcibly take Taiwan. US strategic objectives and political commitment are now clearer than ever, says Bateman. China’s technological rise “will be slowed at any price”.

American concerns are laid bare in a recent 200-page report – led by former Google chief executive Eric Schmidt and Bob Work, deputy defence secretary in both the Obama and Trump administrations – on China’s challenge to US competitiveness. The blandly titled “Mid-Decade Challenges to National Competitiveness” belies its provocative findings – that the US and its allies have “come perilously close to ceding the strategic technology landscape” and are approaching a “critical moment” in the global technology race. The price of losing could be a world beholden to China. “Warfare will be waged with and against industrial and financial power and pit innovation ecosystems against each other.”

Work says US-China technological competition is going to be “the defining feature of global politics for the rest of our lives”. It is going to determine “who is the greatest military power”. It’s a ­competition the US “must win”, with the crucial years being 2025 to 2030.

What this means for Australia and the wider world is that technology and industry policy have become the central arenas of competition in the strategic rivalry between the US and China, permeating every aspect of their relationship. This rivalry will profoundly shape the emerging international system compelling all nations to adapt, make unpalatable political choices and grapple with difficult policy conundrums.

Among them are whether the new era of techno-nationalism forces a major decoupling of global supply chains and a “Balkanisation” of the internet, weakening the vital information and trading architecture underpinning international society. It raises troubling questions about who will set the equally important global rules, standards and norms that govern the way in which countries and companies co-operate and interact and whether the US, or China, can win the looming tech war. If so, at what cost to themselves and others?

International trade and global value chains, already disrupted by the Ukraine conflict and Covid, will be hit hard by the intensifying competition between the US and China. The value of global chip makers’ stocks declined by more than $US240bn in the first week of the US export restrictions and global trade is likely to be reduced by hundreds of billions of dollars annually.

Semi-conductor producing allies Japan, South Korea, Taiwan and the Netherlands aren’t thrilled by the sudden loss of China markets. And they worry about being on the receiving end of potential reprisals from Beijing. US tech firms will suffer too as China is a lucrative customer. Nvidia, which makes graphic processing units used to train AI algorithms, expects $US400m this quarter in lost revenue.

But the US is unlikely to change course. It’s hard to escape the conclusion that China has brought Washington’s wrath upon itself by decades long pilfering of American intellectual property, hidden subsidies and “stealthy regulatory discrimination”. This is not the least of Beijing’s transgressions. “China has used its growing prowess to crush dissenters and minorities, threaten neighbours, prop up foreign autocrats, carry out espionage and influence operations, entrench market dominance and lay the groundwork for future digital sabotage or coercion,” Bateman says.

Much of this has been enabled by Western technology. Witness the onerous and repressive surveillance system used against the Uighurs and the Great Firewall of China which Beijing uses to fence in its own netizens while hacking Western data on an industrial scale with impunity. The supercomputers at the heart of this Orwellian digital control edifice were built with chips made by US companies Intel and Nvidia.

Of even greater concern is evidence that China’s military research groups have covertly acquired specialised American technology to build hypersonic missiles which could be used against the US and its allies, including Australia. A Washington Post investigation last month mapped more than 300 sales of US origin technology since 2019 to “dozens of entities involved in China’s hypersonics or missile programs”.

One of the biggest problems for the US is that China is a top down, techno-security state pursuing a “network great power” strategy aimed at positioning the country to dominate the digital world and shape the emerging world order. Its military and commercial systems are closely intertwined domestically and deeply embedded in the US and global economies.

“Untangling and decoupling this thick interdependence will also inflict huge economic damage to the US and the international economic order,” writes Tai Min Cheung, director of the University of California’s Institute on Global Conflict and Cooperation in an article for the Minerva Research Institute. That’s why US technological decoupling must be targeted, selective and carefully designed to minimise self-damage. It would be folly to sever all economic, scientific and technological ties with the world’s second largest economy.

But blunting China’s techno-mercantilism won’t be enough to maintain America’s tenuous technological lead without a system wide rejuvenation of its entrepreneurial spirit and capacity for ­innovation.

Recognising that advanced computer chips and the fabs that build them are the new oil, Biden has begun to friendshore, reshore and invest in them. In July, Congress passed the $US52.7bn Chips and Science Act, which provides $US13.7bn for R&D and $US39bn for manufacturing subsidies to encourage the building of fabs in the US.

Intel, once a market leader, has committed to a massive $US100bn expansion of its fabs in the US and Germany. Chief executive Pat Gelsinger sees this as a necessary rebalancing of supply chains. In remarks to The Wall Street Journal’s annual Live Tech conference, Gelsinger said that the ambition is to boost domestic chip manufacturing in Western countries and reduce reliance on Asia from 80 to 50 per cent with the US taking 30 per cent and Europe 20 per cent.

Staying ahead of China will require a substantial lift in publicly funded R&D. Although the US spent 3.45 per cent of GDP on R&D in 2020, only 0.7 per cent was publicly funded compared with 1.86 per cent in 1964 at the height of the Cold War. Meanwhile, China’s spending on R&D has grown more than any other country over the past 20 years and is now 2.4 per cent of GDP. If their respective economies continue to grow at current rates, China will spend more on research than the US by 2032. The country has also made impressive strides in academic research with stellar growth in citations and other recognised measures of global research status and influence.

America’s political elites have been galvanised by China’s technology challenge, now seen as a “Sputnik moment” – a reference to the Soviet Union’s shock launch of its Sputnik satellite in 1957, edging it ahead of the US in the first iteration of the space race.

“China has demonstrated the benefits of having an innovation policy, an industrialisation policy and a science and technology policy,” says Walter Copan, former director of the US National Institute of Standards and Technology.

Washington’s response to the first Sputnik moment was to reach for its wallet, enabling it to surge ahead and regain the lead within a decade. But that wallet is much thinner today and China is a cashed up financial heavyweight, unlike the Soviet Union. So, Biden needs tech partnerships with trusted allies and friends, including ­Australia.

His administration has built on established arrangements with other Quad members Australia, Japan and India. The Quad now has a working group on critical and emerging technologies. The administration has also convened new partnerships such as the US-EU Trade and Technology Council and has proposed a “Chip 4” alliance with technology powerhouses South Korea, Japan and Taiwan.

This task has been made easier by the willingness of Republicans to support increased spending on strategic technologies, despite their historical scepticism of public spending and government intervention. Republican and Democrat leaders share the belief that China’s threat to US technological pre-eminence is existential. Free market economists in the US are also more inclined to recognise that greater government intervention is necessary when competing with techno-security states.

This is the geoeconomic context for AUKUS which is essentially a down payment on a commitment by Australia, the US and UK to ramp up collaboration on advanced technologies. “Important as submarines are,” write Nicole Camarillo and Oliver Lewis in Defense One, a Washington-based defence publication, the new way of deterrence will be less about platforms “and far more about the strength, speed and resilience of software”.

The People’s Liberation Army is already moving from a platform centric force to a data centric force, investing heavily in AI and quantum computing to prepare for what Beijing calls “intelligentised warfare”. This plays to its strengths in state-directed investment, unlimited access to data from a co-opted population of 1.4 billion and a military civil fusion doctrine that “compels the commercial sector to help develop military technology”, write Camarillo and Lewis.

The obvious counter for the West is to pool its world class tech and research capabilities. Pillar two of the AUKUS agreement provides unprecedented opportunities for sharing across a raft of critical technologies, particularly chip dependent AI and the likely replacement for today’s electronic computers – quantum computers using qubits. Quantum computing could revolutionise society by solving complex problems in seconds that would take the fastest supercomputer thousands of years.

Research on AI and quantum physics is highly competitive, with the US still in the lead. But China is spending enormous sums of money on both.

The national security stakes are especially high. Data driven AI is becoming the essential building block of modern defence systems. US Secretary of Defence Lloyd Austin says that “tech advances like AI are changing the face and pace of warfare”. They are “foundational” to the Pentagon’s joint war fighting concept. The Challenges to National Competitiveness Report recommends that the Biden administration develop an “Offset-X Strategy” to make the country “better prepared and positioned to outsmart, outpace, outmanoeuvre” and outgun the PLA.

Once the realm of science fiction, the US is now testing AI systems to predict what the enemy will do next in near real time. This could give the allies decision-making ­superiority that could be decisive on the battlefield. Russian President Vladimir Putin has declared that whichever country becomes the leader in AI “will become the ruler of the world”. Unfortunately for Putin, a key reason for his repeated failures in Ukraine is the ­inability of the Russian military to harness AI’s potential.

Xi is determined not to make the same mistake. If his scientists win the quantum race, he could secure China’s secrets while reading the secrets of other countries at will by cracking their encryption systems.

This is the challenge confronting the West. We can choose to compete or be swept along in China’s wake.